A small Nebraska Bank failed recently. According to newspaper reports, the failure was due to "large out-of-territory commercial loan losses" and "poor management practices" , including excess of lending limits and improper extensions of maturity dates on related-party loans. While the bank’s legal lending limit was approximately $2 million, it is not clear how much of the $5.5 million in charge-offs during Q4 2019 resulted from these related-party loans.
But there are “other” take-aways from this small bank failure:
What is “out-of-territory”? This bank was located in a county with a population of less than 1,000 people. To achieve the $100 million size, serving customers outside of this county did occur. How far away from the headquarter county is “out-of-territory”? FinTech firms are lending to parties across the country - when is their activity “out-of-territory”?
What role did agricultural lending play in this failure? This bank had over 77% of its loans related to agriculture and farmland. Did the concentration of lending coupled with the troubled state of the agricultural sector play a key role in this failure?
Over 2,500 Community Banks are headquartered and serve counties with populations of less than 50,000. And over 20 percent of these banks have agricultural concentrations of 50 percent. These concentrations are probably not created recently, but occurred historically. These concentrations are an outcome of the economies and customers of these rural markets. And many of these Community Banks serve customers in other counties where there may not be another headquartered bank.
Several states have large numbers of these rural agricultural banks, including Nebraska where this bank failure was located. Nebraska, Iowa and Kansas have more than 70 Community Banks that have agricultural concentrations greater than 50 percent. These bank management teams must be able to manage bank lending against external events (falling commodity prices, unexpected international trade wars, etc.).
Capital is one component of these management practices. Higher capital ratios are needed when loan concentrations are high due to the nature of the markets that these banks serve. 98 percent of Community Banks serving markets with populations of less than 50,000 hold strong capital positions with Leverage Ratios exceeding 9%.
But there will always be those outliers that have low capital levels while maintaining high loan concentrations. The number of these banks are small - perhaps less than 25. But these banks remain susceptible to a sustained downturn in the agricultural marketplace. And there may be an additional failure.